Introduction:
Get the latest trend about Private Real Estate Investing here! Here’s how investors can get involved in private equity real estate, as well as an overview of the industry’s prospects, risks, and constraints.
Private equity real estate funds enable high-net-worth individuals and institutions such as endowments and pension funds to participate in property equity and debt. Private equity real estate uses an active management technique to diversify property ownership. General partners invest in various property types in different locations. Ownership options might include everything from new construction and raw land holdings to the total rehabilitation of existing properties and cash-flow injections into struggling enterprises.
Here’s how investors can get involved in private equity real estate, as well as an overview of the industry’s prospects, risks, and constraints.
Discovering the Best Private Equity Real Estate Funds
First, the average person cannot participate in private-equity real estate ventures. The standard private-equity fund asks investors to contribute a minimum of $250,000. Still, most managers are looking for people or organizations willing to invest up to $25 million in a long-term collective investment scheme with other investors.
Due to the lack of regulation of private equity real estate funds, opportunities have typically been confined to “accredited investors.” This means that the investor must have at least $1 million in personal or joint assets (excluding the value of their principal residence) or a yearly income of at least $200,000. Couples with at least $300,000 in combined income over the previous two years and a “reasonable expectation” that their income levels will continue at this level in the current year are also eligible.
Individuals or couples interested in investing in private equity real estate should seek a firm specializing in the field. When analyzing a private equity firm’s fund alternative, they should be aware of the form of each private equity fund, which is often a limited partnership.
Outside investors that join a fund become limited partners, which means they assume accountability for the money they invest in the fund and have no veto power over the properties chosen by the general partners (GPs). The funds of a limited partner will be pooled with those of other participating investors, and fund managers will construct a portfolio of properties to maximize profits while minimizing financial risk.
Understanding the Costs and Investment Structure of the Fund
Private equity real estate funds have several management and performance fees that investors must pay. Private equity funds typically charge 2% of the money invested to cover company wages, deal sourcing and legal services, data and research expenditures, marketing, and other fixed and variable costs. These investor fees, however, have no upper limit.
Individuals should understand these fees before investing because they will reduce the total return on investment. For example, if a private equity real estate firm raised $500 million, it would receive $10 million in annual revenue to cover expenses. A fund would generate $100 million in fees throughout its 10-year cycle, implying that only $400 million would be invested during that time.
Private equity executives are also given a “carry, “which is a performance fee typically equal to 20% of the fund’s excess gross profits. Investors have traditionally been ready to pay these fees due to the fund’s ability to help alleviate corporate governance and management concerns that could harm a public firm.
Most private equity real estate funds are “need-based,” which means that partners commit capital to general partners in installments as needed. As GPs identify viable investment properties, the fund will issue a formal request for capital from the limited partners. The latter pledged capital to the real estate fund at the start of the cycle. This is referred to as a “capital call.” “It is a legal requirement that the limited partners must meet.
If a limited partner fails to meet a capital call, the fund may push that individual or entity into default, forfeiting their whole ownership stake. In the case of a default, other limited partners are usually allowed to purchase any forfeited shares.
Despite the pandemic, certain private real estate sectors experienced spectacular recoveries, including multifamily housing, industrial, and life sciences, according to the Urban Land Institute’s Emerging Trends in Real Estate report. Nonetheless, private real estate investing will be hampered by the coronavirus. However, investment decisions cannot be postponed indefinitely. Higher risk is now the norm, and the costs of planning one’s life around COVID-19 may have begun to outweigh the benefits.
That being said, here are our top ten private real estate investing forecasts for the coming year. We will continue focusing on multifamily housing, preparing our funds for short- and long-term success.
1. Inflation is our most serious economic concern, and it will affect all other trends.
I’m not the only one who is concerned about inflation. Jon Gray of Blackstone and Paul Tudor Jones of Just Capital believe it is more than a fad. Inflation rose 6.8 percent in November, the quickest rate since 1982. Supply chain expenses might push volatile pricing well, but increased salaries will have a long-term impact that the Federal Reserve may overlook. Sustained inflation in private real estate will impact everything from value-add and ground-up building to capital expenditures and cap rates. It all comes back to labor and the supply chain—there is no one to unload freight or sell fast food. Higher wages are the only way to incentivize labor. You can’t take it away; it’s a one-way street. As a result, inflation and its volatility pricing will be more durable.
2. Interest rates will rise.
Based on current inflation levels, interest rates will rise this year. If a 10-year Treasury note yields 1.6 percent and inflation is 3%, investors expect a real return but receive a 1.4 percent loss. Inflation is, in fact, far higher than the 10-year Treasury rate. The Fed may begin hiking interest rates in May or July, far sooner than anticipated. Interest rates linked to inflation are not always bad, and I hope rates grow gradually by less than a full percentage point. A range of 2 percent to 2.5 percent is preferable to a range of 1% to 2%; you don’t want big changes like a whole point.
3. COVID will remain to impact real estate since it alters where we live and how we work.
COVID-19 caused widespread disruption in the economy. People did not work for three, six, or even nine months before finding new employment. Otherwise, they would not risk returning to retail or office places. Many people discovered that they now had feasible remote job possibilities. In September, a record 4.2 million people resigned from their employment. These tremendous labor shortages are inflationary. Wages are greater and are not going down, whether at a port, a construction site, or a fast-food restaurant. Workplace changes aren’t merely temporary; a hybrid atmosphere may be the only way to attract the most sought-after applicants.
4. The level of appreciation will be lower than last year.
Although we are not in a bubble, valuations are at the upper end of their predicted range. It’s time to be careful, employ low leverage, and only invest in assets with a high potential for cash flow. Because the historical return on the stock market has been only 8% or 9%, we will eventually see smaller returns. When the risk-free rate of return is 0, private real estate investors cannot expect returns of 15% to 20% over the following ten years. This does not imply a correction; profit expectations will moderate.
5. The migration of people from large cities to low-cost, business-friendly states continues.
Continued virtual and hybrid labor will hasten migration to warmer Southern areas with reduced housing expenses and taxes. A tight labor market encourages remote employees to be hired outside our country’s biggest economic centers, sometimes gateway cities. Housing prices are growing in Charlotte, Denver, and Phoenix places with a better lifestyle, lower housing expenses, and better weather than Boston, Chicago, Los Angeles, New York City, or San Francisco. Rising housing costs will reduce this tendency over time. Exodus from California has benefited Phoenix with lower income taxes and larger houses, but the price differential is decreasing as Phoenix’s rent growth rate approaches San Diego’s rent growth rate. Affordability will eventually mitigate these price distortions, but this will take years.
6. The benefits of the Qualified Opportunity Zone (QOZ) will remain unchanged.
Last year, new rules limiting the QOZ’s hefty benefits appeared on the way. Still, the congressional impasse has postponed adjustments in capital gains taxes and possibly even marginal tax rates. This reduces the likelihood of QOZ incentives for private real estate investment being reduced in the coming year. After a 10-year holding term, QOZs eliminate taxes on any capital gains realized. QOZ funds have attracted more than $20 billion, demonstrating sustained investor interest. The United States Treasury and Internal Revenue Service may exercise rulemaking authority, but no QOZ rules will alter in the near year. Democrats enjoy the idea that it encourages investment in developing regions, while Republicans will defend the tax cuts—and Congress is so gridlocked that getting anything enacted is tough.
7. Multifamily real estate will experience a modest valuation increase and robust rent growth, with suburbs surpassing cities.
There are still a large number of investors looking to put money into multifamily housing. The environment for rent growth continues to be favorable, and properties will see some appreciation, but less than in the previous year. When borrowing costs rise, so do the cost of borrowing and the cost of a company’s capital. This lowers the company’s equity multiple or earnings multiple. However, the potential of inflation implies that rents will continue to grow as employees’ incomes increase, giving them more money to spend on rent. Remote and hybrid workplace patterns favor suburban development over urban core development.
8. Multifamily rents in the Northeast and Midwest will underperform those in the Southeast, Southwest, and Texas.
We stated last year that too many individuals had departed cities for multifamily urban Class-A rentals to recover. Higher salaries and disposable income will fuel rent increases in urban and suburban areas, ensuring that multifamily real estate remains a viable investment. However, suburban rent growth will continue to outstrip urban rent growth. At the same time, urban Class-A buildings continue to outperform urban Class-B and suburban assets due to their affordability.
9. Value-added construction is giving way to the ground-up building.
Because acquisitions are now priced at or above replacement cost, value-add upgrades must provide significant competitive benefits to justify private equity investment. With so much capital flowing into value-add projects in recent years, their cost basis has surpassed that of brand-new apartments in relative location and quality. That makes achieving investors’ expected returns difficult because recent construction always commands premium rents. A landscape of lower price appreciation moves the risk and reward balance in favor of new construction, leading us to exit the value-add market for now; it’s not a business we assume is investible in this market environment.
10. The pace of new construction from the ground up will pick up.
As the price of land and building materials rises, the profit margin for new construction will be reduced, and the market will return to value-added services. However, for the time being, new construction from the ground up will continue to be popular.
It pays to be agile and foresee future multifamily as other real estate market changes. Come join us and let’s grow together.
******************************
Come join us! Email me at mark@dolphinpi.us to find out more about our next real estate investment.